Question

1. Armand has a weekly budget of $40 which he can spend on magazines and pies. Magazines cost $10 each and a pie is $5. Indicate the opportunity set on (a) Draw Armand's budget constraint on the graph provided. the graph. Magazines Pies (6) Determine if each of the following combinations are in Armand's opportunity set or not. i. Two magazines and four pies ii. One magazines and five pies iii. Three magazines and three ples (c) What is the opportunity cost of one magazine in this scenario? (d) What would happen to Armand's opportunity set if inflation caused the price of pies, the price of magazines, and Armand's budget to all double?

Answer 1

(a) The budget line can be drawn as follows. With a budget of $40, if all money is spent on pies, Armand can afford 40/5 = 8 pies. Hence, the horizontal intercept of the budget line is 8. Similarly, if money is spent only on magazines, Armand can afford 40/10 = 4 magazine. Hence, the vertical intercept of the budget line is 4. If we connect 8 on the x-axis (or pies axis) and 4 on the y-axis (or magazine axis), we get the required budget line. The budget line is represented by AB in the figure below.

Opprtunity Set Magazines 5.1 Pies

The opportunity set is defined as the all the combinations of pies and magazines that affordable within the budget. Hence, the set of all bundles of pies and magazines in the shaded area and on the budget line are part of opportunity set.  

(b) (i) Two magazines and 4 pies are in Armand's opportunity set as this combinations lies on the budget line which is also included in the opportunity set. The point is shown as (4,2) in the diagram above.

(ii) One magazine and five pies. As shown by the point (5,1) in diagram above, this combination is also in Armand's opportunity set. That is Armand can afford to buy this combinations given the budegt.

(iii) Three magazines and 3 pies. This combination is outside of the opportunity set as shown in the diagram with the point (3,,3).

(c) The opportunity cost of one magazine equals 2 pies since to get one magazine (cost = $10), Armand has to give up 2 pies (cost = $5x2=$10).

(d) If inflation caused the price of pies, the price of magazine and Armand's budget to all double, the budget line and the opportunity set remains unchanged. Since, with double income (i.e., $80), Armand can afford same units of magazines ($80/$20 = 4) if all money is spent on magazine. Similarly, same units of pies (8) will be affordable with the new budget. Hence, the budget line does not change at all and hence, the opportunity set also remains same.